S&P 500 Correlation Bets Increase as VIX Rebounds 22%

By Cecile Vannucci and Nikolaj Gammeltoft -
Apr 9, 2012

Options traders are speculating the
lockstep moves in U.S. equities that punished investors last
year are on the way back as the benchmark volatility gauge posts
its longest streak of increases since 2003.

The Chicago Board Options Exchange S&P 500 Implied
Correlation Index rose 14 percent in nine trading sessions to
66.64 yesterday, rebounding from a 10-month low and posting the
biggest gain since August, data compiled by Bloomberg show. The
gauge uses options to measure expectations about whether
Standard & Poor’s 500 Index stocks will move in unison. At the
same time, the Chicago Board Options Exchange Volatility Index,
or VIX, has surged 22 percent since March 28.

Links among stocks diminished after climbing to a record in
2011 on concern European leaders were failing to contain their
debt crisis. Options traders are betting they will tighten after
U.S. employers added the fewest jobs in five months and analysts
projected the weakest earnings growth since 2009.

“We have renewed fears about political and macroeconomic
events,” Brian Jacobsen, who helps oversee $211 billion as
chief portfolio strategist at Wells Fargo Advantage Funds in
Menomonee Falls, Wisconsin, said yesterday in a phone interview.
“It makes sense that implied correlations are increasing.”

Stocks moved in unison last year by the most since at least
1980, according to data compiled by Birinyi Associates Inc. The
average correlation coefficient between the index and its 500
companies increased to 0.86 on Oct. 10, a week after the
benchmark gauge for American equity hit a one-year low and the
VIX reached a high of 45.45. The relationship tightened as the
S&P 500 plunged 19 percent between April and October.

Best Since 1998

The S&P 500 has risen 26 percent since then, including its
biggest first-quarter gain since 1998. The gauge for U.S.
equities touched 1,419.04 on April 2, reaching its highest level
since May 2008, after reports showed retail sales and
manufacturing improving while unemployment falls.

Rallying stocks pushed the CBOE implied correlation index
down to 58.26 on March 26, its lowest level since May, from a
record high of 83.94 on Dec. 16. It then rebounded in the past
two weeks.

The VIX rose 13 percent to 18.81 yesterday, its highest
level in a month, after employers in the U.S. added 85,000 fewer
jobs than the median economist projection, according to data
compiled by Bloomberg.

“We’re in a corrective phase and people are protecting
themselves,” Bob Baur, chief global economist at Principal
Global Investors, which oversees about $242 billion, said
yesterday in a phone interview. “The economic data is softening
and there’s a lot of risk in the market.”

Fed Statement

The benchmark gauge of American options prices has risen
seven straight days, the longest streak since 2003. Last week,
it advanced as the S&P 500 completed its biggest drop of 2012.
Stocks slumped during the holiday-shortened week after the Fed
signaled it will refrain from further monetary stimulus.

Equities fell and the VIX advanced as concern about the
European debt crisis intensified last week. Spain, the fourth-
biggest economy in the region, sold 2.59 billion euros ($3.4
billion) of bonds at an auction, near the minimum. Spain is in
“extreme difficulty,” Prime Minister Mariano Rajoy said April
4, raising the possibility of a bailout.

Profit growth at S&P 500 companies slowed to 0.8 percent in
the first quarter, according to estimates for per-share income
compiled by Bloomberg. That compares with a 4.9 percent increase
for the last quarter of 2011, the data show.

Earnings Season

Alcoa Inc. (AA), the biggest U.S. aluminum producer, will become
the first Dow Jones Industrial Average company to post first-
quarter results today. Options are pricing in a 6 percent rise
or fall in the stock tomorrow, following the report, according
to data compiled by Bloomberg. That compares with the average
move of 2.4 percent after the last eight quarterly statements,
data compiled by Bloomberg show.

The 30-day correlation for the S&P 500’s 50 biggest stocks
more than doubled to 0.42 on April 4 from the one-year low seen
on Feb. 8, data compiled by BMO Capital Markets Corp. show.

“It’s a little bit of a worrisome sign,” Max Breier, a
senior equity derivatives trader at BMO in New York, said in an
April 4 telephone interview. “Given the high correlation, any
kind of a pattern of earnings shortfalls could lead to an
accelerated downside move.”

Improved Outlook

The Fed last month upgraded its assessment of the economic
outlook. U.S. consumer confidence climbed to the highest level
in four years in the week ended April 1, the Bloomberg Consumer
Comfort Index showed on April 5, while manufacturing in the
nation expanded at a faster pace in March and retail sales rose
in February by the most in five months.

“Everything we’ve seen recently in the market can be
contained within the confines of what we call a healthy break,”
Christopher Johnson, chief investment strategist at Johnson
Research Group LLC in Cincinnati, said yesterday in a phone
interview. “On balance we are seeing improvements in the
economy,” he said. “Investors will always find something to
worry about.”

Options traders have been increasing protection for their
S&P 500 gains, bringing the cost of bearish contracts to the
highest level in almost five years versus calls.

Implied volatility, the key gauge of prices, for puts 10
percent below the S&P 500 rose to 22.88 on April 9, while the
measure was 14.42 for calls 10 percent above, according to data
on six-month contracts compiled by Bloomberg. That brought the
price relationship known as skew to 1.59, close to the 1.64
level from March 13, which was the highest since May 2007.

Getting Nervous

The ratio of outstanding puts to sell the S&P 500 versus
calls to buy rose to 1.95-to-1 on April 4 after reaching 1.97
last month, the highest since October 2008, the data show.

“People are starting to get nervous again about the big
macro drivers,” George Feiger, chief executive officer of
Contango Capital Advisors Inc., the San Francisco-based wealth
management arm of Zions Bancorporation, said in a telephone
interview on April 5. He manages about $3.3 billion at Contango
and Western National Trust Co. “It becomes much more important
to do the risk-on, risk-off trade than to make subtle
discriminations between companies.”